News Analysis: US stock markets remain vulnerable despite the robust economic outlook

The Dow Jones' recent roller-coaster ride showed just how sensitive New York shares are

THE UNITED States economy is heading towards the longest boom in history. Inflation is low, wages are rising at a moderate pace, and every economic forecast says that things are heading in the right direction.

The IMF forecast last week says that America is going to have a soft landing, with no rapid collapse in growth or sudden burst of inflation. So why is the stock market so unhappy?

The fear stems not so much from any concern about new information on the macroeconomy as from a series of interlinked factors that could upset the financial basis for the strong US recovery. The dollar has showed unforeseen weakness against the yen, and the Federal Reserve, having raised interest rates twice this year already, has hinted that it might move them again when it meets next week.

On Tuesday, stocks had a hair-raising ride in New York with the Dow Jones Industrial Average down more than 200 points at one stage only to recover later in the day to end down 27.86. At its lowest, it was just 80 points above the 10,000 mark, through which it so boldly soared earlier in the year to much fanfare. Both the Dow and the S&P 500 were, for much of the day, more than 10 per cent down on their high for the year, the point at which analysts start talking about an official market correction.

Yet the underlying economic figures continue to be positive, after all. The durable goods figures released yesterday showed a continuing strong demand for new aircraft and cars, the fourth month in which orders advanced strongly.

The manufacturing sector is still showing new signs of life. Exports may be picking up as the Asian economies return to strength and Europe stirs. The Conference Board said its register of consumer confidence slipped again in September for the third consecutive month, but it still expects a robust holiday season at stores.

The dollar's weakness against the yen was the subject of intense discussions at last weekend's Group of Seven meetings, and some commitments from Japan did emerge.

The market still fears that the dollar's strength is a thing of the past, despite robust statements from Lawrence Summers, the new US Treasury Secretary. The IMF, in its forecast, projected a dollar decline that would help to correct the trade deficit, even though that decline should be slow and orderly, it said.

In fact, with evidence that the domestic economy is slowing, it seems increasingly unlikely that the Fed will raise rates again when it meets next week. Indeed, some economists believe that the Fed should be moving faster and further.

The Shadow Open Market Committee, a group of private economists, made a rare reappearance on the public stage this week urging more attention to inflation and less on productivity gains.

"They ought to get about their business and stop making excuses as to whether productivity is higher or lower," said Allan Meltzer, a professor at Carnegie Mellon University who is the committee's chairman.

And Fed officials have also been making reassuring comments on other matters.

"I don't think the trade deficit is a problem," said St Louis Federal Reserve president William Poole earlier this week. "So, you should not believe there is any necessary day of reckoning as a consequence of the ongoing trade deficit."

As for Y2K, "Any disruptions or glitches that do occur will be minor and of limited duration," said Federal Reserve Governor Roger Ferguson on Tuesday.

Beyond this, however, the bears who have re-emerged in the past few weeks have pointed out some unhappy facts about the stock market's strength - that buoyancy has for more than a year been concentrated in a few stocks. It is arguable, they say, that Wall Street gave up the ghost in 1998.

Richard McCabe, chief market analyst at Merrill Lynch, says that nearly a quarter of the common stocks on the New York Stock Exchange and Nasdaq are below their lows of last year. A few big stocks have been carrying the apparent boom, and when - as in the past few weeks - confidence slips in them, then the market takes a beating.

So when Microsoft's Steve Ballmer said that technology stocks were massively overvalued and that his own company's stock was too high, it was hardly surprising that technology stocks - especially Microsoft - took a beating.

The mainstream view is that while the stock boom has life left in it, it is likely to be a cautious and steady advance rather than the charges that the Dow has led for the rest of this year.

"Today we think stocks are only modestly undervalued. That suggests to us that stock prices can continue to rise but they will do so in a way that is more commensurate with the actual improvements in our economy, in our corporate profits and the outlook for inflation and interest rates," said Abby Cohen, chief US equity strategist at Goldman Sachs at a seminar on the US economy last weekend.

The returns on stocks will be "good, but not necessarily as fabulous as earlier in the decade".

There are no imminent signs of any event dramatic enough to put the market into sharp reverse; but there are, and have been for a year, plenty of indications that however robust the outlook for the economy, the market was vulnerable.

The pillars upon which the boom was based - weak commodity prices, a strong dollar and lagging markets overseas - have all been put into question.

The massive technological advances of the Internet era are very largely priced into stocks, and then some. Investors seem to be bouncing between taking their profits, and picking up buying opportunities when stocks dip.

Good news, in short, may well be rationed as far as the market is concerned, and the bad news - even if not apocalyptic - may seem more important.

Something like the Taiwan earthquake assumes greater importance in a market like this, and other external factors may well weight the market down. It is likely to be an uncertain drive to the end of the millennium.